UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 

FORM 10-Q

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 

For the quarterly period ended March 31, 2008

OR 

[ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934 

For the transition period from ____________ to ____________ 

Commission file number  0-25958

 

INTEGRITY MUTUAL FUNDS, INC.

(Exact name of registrant as specified in its charter)

 

North Dakota	45-0404061
(State or other jurisdiction	(I.R.S. Employer
of incorporation or organization)	Identification No.)

 

1 Main Street North, Minot, North Dakota, 58703

(Address of principal executive offices)

 

(701) 852-5292

(Registrant's telephone number, including area code)

 

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 

Yes

[X]

No

[ ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. 

Large accelerated filer		[ ]	Accelerated filer	[ ]
Non-accelerated filer		[ ]	Smaller reporting company	[X]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). 

Yes

[ ]

No

[X]

 

As of April 30, 2008, there were 14,455,943 common shares of the issuer outstanding.

 

FORM 10-Q 
INTEGRITY MUTUAL FUNDS, INC. 

INDEX

PART I	FINANCIAL INFORMATION	Page #
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets -
	March 31, 2008 and December 31, 2007	3
	Condensed Consolidated Statements of Operations -
	Three Months Ended March 31, 2008 and 2007	5
	Condensed Consolidated Statements of Cash Flows -
	Three Months Ended March 31, 2008 and 2007	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	16
Item 4.	Controls and Procedures	17
PART II	OTHER INFORMATION
Item 1.	Legal Proceedings	17
Item 1A.	Risk Factors	17
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	17
Item 3.	Defaults Upon Senior Securities	17
Item 4.	Submission of Matters to a Vote of Security Holders	17
Item 5.	Other Information	17
Item 6.	Exhibits	17
	SIGNATURES	18

 

PART I - FINANCIAL INFORMATION 

Item 1.

Financial Statements

  

INTEGRITY MUTUAL FUNDS, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS 

ASSETS

			(Unaudited)
			March 31,				December 31,
			2008				2007
CURRENT ASSETS
	Cash and cash equivalents	$		3,323,836	$	3,143,250
	Accounts receivable			2,285,111		2,191,626
	Prepaids			66,045		69,767
	Total current assets	$		5,674,992	$	5,404,643
PROPERTY AND EQUIPMENT		$		2,200,842	$	2,171,049
	Less accumulated depreciation			(924,256)		(900,204)
	Net property and equipment	$		1,276,586	$	1,270,845
OTHER ASSETS
	Deferred sales commissions	$		86,421	$	165,126
	Goodwill			10,902,258		10,912,548
	Deferred tax asset			115,143		144,719
	Other assets (net of accumulated amortization			212,892		216,949
	of $392,177 for 2008 and $387,534 for 2007)
	Total other assets	$		11,316,714	$	11,439,342
TOTAL ASSETS		$		18,268,292	$	18,114,830

 

SEE NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
LIABILITIES AND STOCKHOLDERS' EQUITY

					(Unaudited)
					March 31,				December 31,
					2008				2007
CURRENT LIABILITIES
		Service fees payable		$		115,707	$	123,724
		Accounts payable				443,044		587,521
		Income taxes payable				85,559		20,512
		Other current liabilities				2,343,813		2,316,171
		Current portion of long-term debt				888,658		888,668
		Total current liabilities		$		3,876,781	$	3,936,596
LONG-TERM LIABILITIES
		Notes payable		$		352,515	$	358,400
		Subordinated commercial notes				561,000		561,000
		Subordinated corporate notes				2,000,000		2,000,000
		Convertible promissory note				950,000		950,000
		Other long-term liabilities				939,444		983,877
		Less current portion of long-term debt				(888,658)		(888,668)
		Total long-term liabilities		$		3,914,301	$	3,964,609
TOTAL LIABILITIES				$		7,791,082	$	7,901,205
STOCKHOLDERS' EQUITY
		Series A preferred stock - 5,000,000 shares authorized, $.0001 par value;		$		305	$	305
			3,050,000 and 3,050,000 shares issued and outstanding, respectively
		Additional paid in capital - series A preferred stock				1,524,695		1,524,695
		Common stock - 1,000,000,000 shares authorized, $.0001 par value;				1,446		1,446
			14,455,943 and 14,455,943 shares issued and outstanding, respectively
		Additional paid in capital - common stock				10,285,398		10,284,900
		Receivable - unearned ESOP shares				(53,705)		(55,379)
		Accumulated deficit				(1,280,929)		(1,542,342)
	TOTAL STOCKHOLDERS' EQUITY			$		10,477,210	$	10,213,625
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY				$		18,268,292	$	18,114,830

SEE NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

INTEGRITY MUTUAL FUNDS, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

					(Unaudited)
					Three Months Ended
					March 31,
				2008		2007
OPERATING REVENUES
	Fee income	$	1,801,669				$	1,957,526
	Commissions		7,481,016					6,250,324
	Total revenue	$	9,282,685				$	8,207,850
OPERATING EXPENSES
	Compensation and benefits	$	812,801				$	1,276,306
	Commission expense		7,154,994					6,129,591
	Sub-advisory expenses		169,879					283,352
	General and administrative expenses		660,473					678,248
	Sales commissions amortized		91,456					105,185
	Depreciation and amortization		28,695					106,657
	Total operating expenses	$	8,918,298				$	8,579,339
OPERATING INCOME (LOSS)		$	364,387				$	(371,489)
OTHER INCOME (EXPENSES)
	Interest and other income	$	204,371				$	98,529
	Interest expense		(82,824)					(81,085)
	Net other income	$	121,547				$	17,444
INCOME (LOSS) BEFORE INCOME TAX BENEFIT (EXPENSE)		$	485,934				$	(354,045)
INCOME TAX BENEFIT (EXPENSE)			(201,647)					122,474
NET INCOME (LOSS)		$	284,287				$	(231,571)
NET INCOME (LOSS) PER SHARE:
	Basic	$	.02				$	(.02)
	Diluted	$	.01				$	(.02)
AVERAGE COMMON SHARES OUTSTANDING:
	Basic		14,514,143					13,961,402
	Diluted		20,819,020					13,961,402

SEE NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

INTEGRITY MUTUAL FUNDS, INC., AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

							(Unaudited)
							Three Months Ended
							March 31,
						2008		2007
CASH FLOWS FROM OPERATING ACTIVITIES
		Net income (loss)			$	284,287			$	(231,571)
		Adjustments to reconcile net income (loss) to net cash provided by operating activities:
			Depreciation and amortization			28,695				106,657
			Sales commissions amortized/charged off			91,457				105,185
			Loss on sale of available-for-sale securities			-				11
			Compensation expense - options			-				5,100
		(Increase) decrease in:
			Accounts receivable			(93,485)				(450,539)
			Income taxes receivable			-				(1,020)
			Prepaids			3,722				6,527
			Deferred tax asset			29,576				(128,350)
			Deferred sales commissions capitalized, net of CDSC collected			(12,752)				(150,080)
			Other assets			(586)				(24,947)
		Increase (decrease) in:
			Service fees payable			(8,017)				11,349
			Accounts payable			(144,477)				213,520
			Income taxes payable			65,047				-
			Other liabilities			42,642				219,199
				Net cash provided (used) by operating activities	$	286,109			$	(318,959)
CASH FLOWS FROM INVESTING ACTIVITIES
		Purchase of property and equipment			$	(29,793)			$	(50,138)
		Purchase of available-for-sale securities				-				(2)
		Sale of available-for-sale securities				-				215
		Purchase of goodwill				-				(50,216)
				Net cash used by investing activities	$	(29,793)			$	(100,141)
CASH FLOWS FROM FINANCING ACTIVITIES
		Issuance of common stock			$	499			$	60,604
		Short-term borrowing				-				120,025
		Reduction of short-term borrowing				(15,000)				-
		Reduction of notes payable				(5,885)				(5,540)
		Reduction of long-term liability				(34,143)				-
		Repayments from ESOP				1,674				1,675
		Preferred dividends paid				(22,875)				(22,875)
				Net cash provided (used) by financing activities	$	(75,730)			$	153,889
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS					$	180,586			$	(265,211)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR					$	3,143,250				1,851,249
	CASH AND CASH EQUIVALENTS AT END OF PERIOD				$	3,323,836			$	1,586,038
	SUPPLEMENTAL SCHEDULE OF NONCASH
	INVESTING AND FINANCING ACTIVITIES:
		Change in unrealized gain on available-for-sale securities			$	-			$	10
		Increase (decrease) in goodwill				(10,290)				1,059,394
		Increase (decrease) in other long-term liabilities				(10,290)				884,394
		Increase (decrease) in common stock				-				175,000
		Compensation expense - options				-				5,100
		Preferred stock dividends declared				22,875				22,875

SEE NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

INTEGRITY MUTUAL FUNDS, INC., AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

March 31, 2008 and 2007 

NOTE 1 - BASIS OF PRESENTATION 

The accompanying condensed consolidated financial statements of Integrity Mutual Funds, Inc., a North Dakota corporation, and its subsidiaries (collectively, the "Company"), included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC").  These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the footnotes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2007, of Integrity Mutual Funds, Inc., as filed with the SEC.  The condensed consolidated balance sheet at December 31, 2007, contained herein, was derived from audited financial statements, but does not include all disclosures included in the Form 10-K and applicable under accounting principles generally accepted in the United States of America.  Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America, but not required for interim reporting purposes, have been condensed or omitted. 

In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments (which are of a normal, recurring nature) necessary for a fair presentation of the financial statements.  The results of operations for the three months ended March 31, 2008, are not necessarily indicative of operating results for the entire year. 

NOTE 2 - RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS 

In December of 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141R, "Business Combinations."  SFAS No. 141R will significantly change the accounting for business combinations.  Under SFAS No. 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions.  Statement No. 141R will change the accounting treatment for certain specific items, including: 

• Acquisition costs will be generally expensed as incurred;
• Non-controlling interests (formerly known as "minority interests") will be valued at fair value at the acquisition date;
• Acquired contingent liabilities will be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount determined under existing guidance for non-acquired contingencies;
• In-process research and development will be recorded at fair value as an indefinite-lived intangible assets at the acquisition date;
• Restructuring costs associated with a business combination will be generally expensed subsequent to the acquisition date; and
• Changed in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. 

SFAS No. 141R also includes as substantial number of new disclosure requirements.  SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  Earlier adoption is prohibited.  Accordingly, a calendar year-end company is required to record and disclose business combinations following existing GAAP until January 1, 2009.  The Company cannot predict what, if any, impact SFAS No. 141R will have on its consolidated financial statements when it becomes effective in 2009. 

In December of 2007, the FASB issued SFAS No. 160, "Non-controlling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51."  SFAS No. 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary.  Specifically, SFAF No. 160 requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financial statements and separate from the parent's equity.  The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement.  SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.  The Company does not believe the adoption of SFAS No. 160 will have a significant effect on the Company's consolidated financial statements. 

In February of 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115."  SFAS No. 159 permits an entity to choose to measure many financial instruments and certain other items at fair value.  SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates.  SFAS No. 159 is effective as of the beginning of an entity's first fiscal year that begins after November 15, 2007.  The Company does not believe the adoption of SFAS No. 159 will have a significant effect on the Company's consolidated financial statements. 

In September of 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements."  SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosure about fair value measurements.  SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements where fair value is the relevant measurement attribute.  Accordingly, SFAS No. 157 does not require any new fair value measurements.  The Company does not believe the adoption of SFAS No. 157 will have a significant effect on the Company's consolidated financial statements. 

NOTE 3 - RECLASSIFICATION 

Certain amounts in the 2007 condensed consolidated financial statements have been reclassified to conform to the 2008 presentation.  These reclassifications had no effect on the Company's net income. 

NOTE 4 - INCOME TAXES 

The Company sponsors several mutual funds.  Deferred sales commissions relating to some of its sponsored mutual funds are amortized over five years for income tax purposes and amortized over eight years for financial reporting purposes.  The effects of these differences will create timing differences between when the commissions are deducted for income tax purposes and expensed as amortization for financial reporting purposes. Deferred tax assets or deferred tax liabilities may result from these timing differences. 

The Company has completed various acquisitions in recent years, whereby the Company acquired the management rights to several mutual funds.   These management rights have been classified as goodwill at the time of acquisition.  The Company amortizes certain goodwill for tax purposes. The Company tests goodwill for impairment annually for book purposes, during the second quarter of each fiscal year.  The annual test is done at the reporting unit level using a fair value approach, in accordance with the provisions of SFAS No. 142.  Deferred tax assets or deferred tax liabilities may result from these timing differences. 

In December of 2005, the Company adopted FASB Statement No. 123R, "Share-Based Payment" (See Note 6 - Stock Warrants, Stock Splits, and Stock Options.)  As a result, the Company expenses stock-based employee compensation for book purposes on the grant date, but does not expense them for tax purposes until such options are exercised.  Deferred tax assets are a result of these timing differences. 

The Company has stated operating loss carryforwards that will expire over the next six to twenty years if unused, as well as a capital loss carryforward that will expire in 2008 if unused.  Deferred tax assets are a result of these timing differences. 

NOTE 5 - BUSINESS ACQUISITIONS 

On April 22, 2005, the Company acquired the management rights to the IPS Millennium Fund and the IPS New Frontier Fund from IPS Advisory, Inc. ("IPS Advisory"), and merged them into a new Integrity Fund called the Integrity Growth & Income Fund.  The two funds had combined assets of approximately $57 million at the time of acquisition.  The purchase agreement called for total consideration of approximately 656,000 common shares of the Company.  The Company provided IPS Advisory with 250,000 common shares upon closing.  The remaining consideration of approximately 406,000 common shares, which was subject to adjustment based on retention of assets in the fund, was issued as follows:  203,000 common shares at the one-year anniversary of the closing date, and 203,000 common shares at the two-year anniversary of the closing date.  The shares are subject to a put option, which allows the holders of the shares to put them back to the Company at a price equal to the market price of the Company's shares as of the closing date, which was $.36 per share.  The put option is exercisable with respect to one-third of the shares per year starting on the third anniversary of the closing date.  The Company will also provide IPS Advisory with a stock option incentive bonus based on growth in assets in the Fund based on the following schedule:  150,000 options on the Company's common shares if assets of the Fund reach $100 million and 150,000 options on the Company's common shares if the assets of the Fund reach $200 million.  The options will have a strike price of $.65 per share and mature 10 years from the closing date.  The securities issued in connection with this transaction were issued on a private placement basis. In April of 2006, the one-year anniversary payment of 158,603 common shares was made, which reflected the assets of the acquired funds at the one-year anniversary.  In June of 2007, the two-year anniversary payment of 138,797 common shares was made, which reflected the assets of the acquired funds at the two-year anniversary.  The liability relating to this acquisition is valued at $197,064 as of March 31, 2008 and has been recorded by the Company as goodwill.

On March 7, 2007, the Company acquired certain assets of United Heritage Financial Services, Inc. (UHFS), a wholly owned subsidiary of United Heritage Financial Group, Inc., of Meridian, Idaho.  UHFS had approximately 120 independent registered representatives who became part of Capital Financial Services, Inc. (CFS), the retail brokerage division of the Company.  Pursuant to the agreement, in exchange for receipt of the assets of UHFS set forth above, the Company agreed to issue 500,000 restricted IMFD shares and pay a deferred cash earn out payment totaling a maximum of $900,000, to be paid in 21 quarterly installments.  On March 7, 2007, the Company issued 500,000 restricted common shares to United Heritage Financial Group, Inc.  As a result of this issuance of shares, $175,000 was recorded by the Company as goodwill relating to the purchase of the assets.  As of March 31, 2008, the Company had made four quarterly installment payments totaling $94,691.  The liability relating to this acquisition is valued at approximately $742,380 as of March 31, 2008, and has also been recorded by the Company as goodwill.  As of March 31, 2008, the total goodwill recorded relating to this acquisition was $1,121,189. 

NOTE 6 - GOODWILL 

The changes in the carrying amount of goodwill for the three months ended March 31, 2008, are as follows: 

	Mutual Fund Services		Broker-Dealer       Services		Total
Balance as of January 1, 2008	$	7,312,606	$	3,599,942	$	10,912,548
Goodwill acquired during the period		-		-		-
Goodwill acquisition price adjustment during the period (see Note 5)		-		(10,290)		(10,290)
Impairment losses		-		-		-
Balance as of March 31, 2008	$	7,312,606	$	3,589,652	$	10,902,258

 

The Company tests goodwill for impairment annually, during the second quarter of each fiscal year, at the reporting unit level using a fair value approach, in accordance with the provisions of SFAS No. 142.  The annual testing resulted in no impairment charges to goodwill in 2007.  If an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value, goodwill will be evaluated for impairment between annual tests. 

NOTE 7 - STOCK WARRANTS, STOCK SPLITS, AND STOCK OPTIONS 

In December of 2005, the Company adopted FASB Statement No. 123R, "Share-Based Payment," ("SFAS No. 123R") which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including employee stock options, based on estimated fair values.  SFAS 123R supersedes the Company's previous accounting under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB25").  Total compensation costs and deferred tax benefits recognized for stock-based compensation awards for the three months ended March 31, 2008 and 2007, were as follows: 

		2008		2007
Compensation costs	$	-	$	5,100
Less:  deferred tax benefit		-		2,000
Compensation costs, net of taxes	$	-	$	3,100

 

Option activity for the twelve months ended December 31, 2007 and the three months ended March 31, 2008 was as follows: 

		Number of Options	Weighted Average Exercise Price per Share		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
Outstanding on January 1, 2007		5,758,113	$	.53	$	.27	$	608,000
	Granted	130,000		.86		.60
	Exercised	-		-		-
	Canceled	-		-		-
Outstanding on December 31, 2007		5,888,113	$	.54	$	.28	$	1,081,950
	Granted	-		-		-
	Exercised	-		-		-
	Canceled	-		-		-
Outstanding on March 31, 2008		5,888,113	$	.54	$	.28	$	87,100

 

Exercisable options at December 31, 2007 and March 31, 2008 were 5,888,113 and 5,888,113, respectively. 

NOTE 8 - DEBT 

Long-term debt at March 31, 2008 and December 31, 2007 was as follows:

Summaries of the terms of the current long-term debt agreements follow: 

First Western Bank - In June of 1999, the Company converted its outstanding balance of $500,000 borrowed on its bank line-of-credit to long-term debt.  The debt was refinanced in October of 2005 and currently carries an interest rate of 7.25%, with monthly payments of $4,105.  On October 1, 2010, the remaining balance will be due in full.  

Subordinate Commercial Notes - In July of 2002, the Company approved a $1 million intra-state subordinate commercial note offering limiting the sale in North Dakota, to North Dakota residents only.  The subordinate commercial notes do not represent ownership in the Company.  As of March 31, 2008, $561,000 in subordinate commercial notes were outstanding.  The subordinate commercial notes carry an interest rate of 9% per annum, payable semi-annually, and mature June 30, 2008.  The Company can call the subordinate commercial notes at par anytime after July 1, 2003. 

Subordinate Corporate Notes  - In May of 2005, the Company approved a $2 million intra-state subordinate corporate note offering limiting the sale in North Dakota, to North Dakota residents only.  The subordinate corporate notes do not represent ownership in the Company.  As of March 31, 2008, $2,000,000 in subordinate corporate notes were outstanding.  The subordinate corporate notes carry an interest rate of 9.25% per annum, payable annually, and mature January 1, 2011.  The Company can call the subordinate corporate notes at par anytime after December 1, 2007. 

Convertible Promissory Note  - In October of 2006, the Company issued a $950,000 convertible promissory note to PawnMart, Inc., in a private placement.  The unsecured note carries an interest rate of 6.5% per annum, payable semi-annually, and matures on October 15, 2016.  The holder of the note has the right, at any time after October 15, 2009, to convert the note in whole or in part, into $0.0001 par value common shares of the Company.  The conversion price shall be equal to $0.50 per share.  The entire principal amount of this note shall be automatically converted into common shares at the conversion price on October 15, 2016.    

Future Payments on Acquisitions - see Note 5 - Business Acquisitions 

NOTE 9 - EARNINGS PER SHARE 

Basic earnings per share are computed by dividing earnings available to common shareholders by the weighted average number of common shares outstanding during the period.  Diluted earnings per share reflect per share amounts that would have resulted if dilutive potential common shares had been converted to common shares.  The following reconciles amounts reported in the financial statements: 

	Three Months Ended March 31, 2008							Three Months Ended March 31, 2007
		Numerator	Denominator		Per Share Amount		Numerator		Denominator		Per Share Amount
Net Income (Loss)	$	284,287				$	(231,571)
Less:  Preferred Stock Dividends		(22,875)					(22,875)
Income Available to Common Shareholders - Basic Earnings per Share	$	261,412	14,514,143	$	.02	$	(254,446)		13,961,402	$	(.02)
Effect of Dilutive Securities:
Convertible Promissory Note Interest (net of taxes)		9,263	1,900,000				-		-
Preferred Stock Dividends		22,875	3,050,000				-		-
Stock Options and Warrants		-	1,354,877				-		-
Income Available to Common Shareholders - Diluted Earnings per Share	$	293,550	20,819,020	$	.01	$	(254,446)		13,961,402	$	(.02)

 

Options and warrants to purchase 3,531,113 common shares at exercise prices between $0.60 and $1.43 were outstanding at March 31, 2008, but were not included in the computation of diluted earnings per share for the quarter ending March 31, 2008.  The options and warrants were not included in the calculations because their exercise prices were greater than the average market price of the common shares during those periods. 

The Company had outstanding, at March 31, 2008, 3,050,000 Series A preferred shares.  The preferred shares are entitled to receive a cumulative dividend at a rate of 6% per year, payable quarterly.  The preferred shares are convertible to the Company's common shares at the rate of one share of common shares for one share of Series A preferred shares at any time after issuance. 

Additionally, the Company had outstanding at March 31, 2008, a $950,000 convertible promissory note.  The unsecured note carries an interest rate of 6.5% per year, payable semi-annually, and matures on October 15, 2016.  The holder of the note has the right, at any time after October 15, 2009, to convert the note in whole or in part, into common shares of the Company at a conversion price of $0.50 per share.  The entire principal amount of this note shall be automatically converted into common shares at the conversion price on October 15, 2016. 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

GENERAL 

Integrity Mutual Funds, Inc., derives a portion of its revenues and net income from providing investment management, distribution, shareholder services, fund accounting, and other related administrative services to the open-end investment companies known as "Integrity Mutual Funds," "Integrity Managed Portfolios," and "The Integrity Funds," hereinafter collectively referred to as "the Funds."  Integrity Mutual Funds currently consists of three open-end investment companies, including ND Tax-Free Fund, Inc., Montana Tax-Free Fund, Inc., and Integrity Fund of Funds, Inc.  Integrity Managed Portfolios currently consists of one open-end investment company containing six separate series, including the Kansas Municipal Fund, Kansas Insured Intermediate Fund, Nebraska Municipal Fund, Oklahoma Municipal Fund, Maine Municipal Fund, and New Hampshire Municipal Fund.  The Integrity Funds currently consists of one open-end investment company containing four separate series, including Integrity Small Cap Growth Fund, Integrity High Income Fund, Integrity Growth & Income Fund, and Integrity Total Return Income Fund.  Capital Financial Services, Inc. ("CFS"), the Company's broker-dealer subsidiary, provides another substantial portion of revenues through sales of mutual funds, insurance products, and various other securities. 

The Company organizes its current business units into two reportable segments: mutual fund services and broker-dealer services. The mutual fund services segment provides investment advisory, distribution, shareholder services, fund accounting, and other related administrative services to the Funds. The broker-dealer services segment distributes securities and insurance products to retail investors through a network of registered representatives. 

The Company's reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. 

Segment Information 

	Mutual Fund		Broker-Dealer
As of, and for the three months ended:	Services		Services		Total

 

March 31, 2008

Revenues from external customers	$	1,367,951	$	7,914,734	$	9,282,685
Inter-segment revenues		(8,672)		16,438		7,766
Interest expense		82,824		-		82,824
Sales commissions amortized		91,456		-		91,456
Depreciation and amortization		24,745		3,950		28,695
Income before income tax expense		52,916		433,018		485,934
Income tax expense		(31,947)		(169,700)		(201,647)
Net income		20,969		263,318		284,287
Segment assets		14,142,944		4,203,740		18,346,684
Expenditure for segment assets		14,652		15,141		29,793

 

March 31, 2007

Revenues from external customers	$	1,870,567	$	6,337,283	$	8,207,850
Inter-segment revenues		-		25,948		25,948
Interest expense		81,085		-		81,085
Stock-based employee compensation		5,100		-		5,100
Sales commissions amortized		105,185		-		105,185
Depreciation and amortization		104,620		2,037		106,657
Income (loss) before income tax benefit (expense)		(545,997)		191,952		(354,045)
Income tax benefit (expense)		197,674		(75,200)		122,474
Net income (loss)		(348,323)		116,752		(231,571)
Segment assets		13,892,685		3,082,728		16,975,413
Expenditure for segment assets		22,719		27,419		50,138

 

Reconciliation of Segment Information 

			For the Three Months Ended
	March 31, 2008			March 31, 2007
Revenues:
Total revenues for reportable segments	$	9,290,451		$	8,233,798
Elimination of inter-company revenues		(7,766)			(25,948)
Consolidated total revenues	$	9,282,685		$	8,207,850
Profit:
Total reportable segment income (loss)	$	284,287		$	(231,571)
Assets:
Total assets for reportable segments	$	18,346,684		$	16,975,413
Elimination of inter-company receivables		(78,392)			(78,392)
Consolidated assets	$	18,268,292		$	16,897,021

  

A substantial portion of the Company's revenues depends upon the amount of assets under its management. Assets under management can be affected by the addition of new funds to the group, the acquisition of another investment management company, purchases and redemptions of mutual fund shares, and investment performance, which may depend on general market conditions. 

ASSETS UNDER MANAGEMENT 

By Investment Objective
	As of March 31,
	2008	2007	% Change

 

FIXED INCOME
Tax-Free Funds	$	187,802,827	$	206,582,433	(9.1)%
Taxable Funds (Corporate/Government)		119,862,794		166,402,467	(28.0)%
TOTAL FIXED INCOME FUNDS	$	307,665,621	$	372,984,900	(17.5)%
EQUITY
Equity Funds	$	39,725,748	$	69,116,585	(42.5)%
Fund of Funds		11,755,077		11,905,290	(1.3)%
TOTAL EQUITY FUNDS	$	51,480,825	$	81,021,875	(36.5)%
TOTAL ASSETS UNDER MANAGEMENT	$	359,146,446	$	454,006,775	(20.9)%
Average for the Three Month Periods	$	367,592,049	$	451,680,683	(18.6)%

 

Assets under the Company's management were $359,146,446 at March 31, 2008, a decrease of 9.2% from $395,664,082 at December 31, 2007, and a decrease of 20.9% from $454,006,775 at March 31, 2007. 

RESULTS OF OPERATIONS 

	Three Months Ended March 31,
	2008		2007
Net income (loss)	$	284,287	$	(231,571)
Income (loss) per share:
Basic	$	.02	$	(.02)
Diluted	$	.01	$	(.02)

 

The Company reported net income for the quarter ended March 31, 2008, of $284,287, compared to a net loss of $231,571 for the same quarter in 2007. 

Operating revenues 

Total operating revenues for the quarter ended March 31, 2008 were $9,282,685, an increase of 13% from $8,207,850 for the quarter ended March 31, 2007.  The increase results from increased commission and fee income relating to CFS, the Company's broker-dealer division. 

Fee Income 

Fee income for the quarter ended March 31, 2008 was $1,801,669, a decrease of 8% from $1,957,526 for the quarter ended March 31, 2007.  The decrease was due to a reduction in fee income received by the mutual fund division due to lower net asset levels in the Funds. 

The Company receives fees for providing investment advisory services to the Funds.  In some cases, all or a portion of the investment advisory fees received by the Company are paid to outside investment advisors for advisory services provided to the Funds.  These fees constituted 5% of the Company's consolidated revenues for the quarter ended March 31, 2008.  

The Company also earns investment advisory fees in connection with CFS' registered investment advisor.  The Company pays the registered representatives a portion of this fee income as commission expense and retains the balance.  These fees constituted 6% of the Company's consolidated revenues for the quarter ended March 31, 2008. 

The Company receives fees from the Funds for providing transfer agency, fund accounting, and other administrative services.  These fees constituted 5% of the Company's consolidated revenues for the quarter ended March 31, 2008. 

The Company earns Rule 12b-1 fees in connection with the distribution of Fund shares.  A portion of these fees are paid out to other broker-dealers, with the remaining amount retained by the Company to pay for expenses related to the distribution of the Funds.  These fees constituted 3% of the Company's consolidated revenues for the quarter ended March 31, 2008. 

Commission Income 

Commission income includes CFS commissions and 12b-1 fees associated with the sale of mutual funds, insurance products, and various other securities.  The Company pays the registered representatives a percentage of this income as commission expense and retains the balance.  Commission income also includes underwriting fees associated with sales of Fund shares subject to front-end sales loads ("FESLs"), and the dealer commission associated with sales of Fund shares subject to FESLs, which is paid out to other broker-dealers as commission expense.  Commission income for the quarter ended March 31, 2008 was $7,481,016, an increase of 20% from $6,250,324 for the quarter ended March 31, 2007.  The increase was due primarily to ongoing recruiting efforts for new registered representatives in CFS.  Commission revenues constituted 81% of the Company's consolidated revenues for the quarter ended March 31, 2008. 

Operating expenses 

Total operating expenses for the quarter ended March 31, 2008 were $8,918,298, an increase of 4% from $8,579,339 for the quarter ended March 31, 2007.  The increase resulted from increased commission expense, which corresponds to the increase in commission income. 

Compensation and benefits 

Compensation and benefits expense for the quarter ended March 31, 2008 was $812,801, a decrease of 36% from $1,276,306 for the quarter ended March 31, 2007.  The decrease resulted primarily from a separation agreement entered into by the Company in 2007, as well as a reduction in compensation paid to employee-status wholesalers due to decreased sales activity in the Funds. 

On January 24, 2007, the Company announced the retirement of Robert E. Walstad, the Company's founder, chief executive officer and chairman of the board of directors, effective February 1, 2007.  In connection with Mr. Walstad's retirement, the Company entered into a separation agreement with Mr. Walstad.  Under the terms of the separation agreement, subject to Mr. Walstad meeting his obligations thereunder in all respects, Mr. Walstad is entitled to receive a cash payment in the amount of $274,500, options to purchase 60,000 common shares, and certain commission payments.  The $274,500 separation payment was expensed in February of 2007. 

Commission expense 

Commission expense for the quarter ended March 31, 2008 was $7,154,994, an increase of 17% from $6,129,591 for the quarter ended March 31, 2007.  The increase corresponds with the increase in commission income. 

Sub-advisory expense 

Total sub-advisory expenses for the quarter ended March 31, 2008 were $169,879, a decrease of 40% from $283,352 for the quarter ended March 31, 2007.  The decrease was due to reduced sub-advisory fees paid due to lower net assets levels in the Funds.  Sub-advisory fees are paid to outside investment advisors for advisory services provided to certain of the Funds.  The amounts of sub-advisory fees paid out can be expected to decrease if the net asset levels in the Funds decrease. 

General and administrative expense 

Total general and administrative expenses for the quarter ended March 31, 2008 were $660,473, a decrease of 3% from $678,248 for the quarter ended March 31, 2007.  The decrease was due primarily to lower Fund distribution costs, which was due to a reduction in sales activity in the Funds. 

Sales commissions amortized 

Sales commissions amortized during the quarter ended March 31, 2008 were $91,456, a decrease of 13% from $105,185 for the quarter ended March 31, 2007.  The decrease was due primarily to decreased sales activity in the Funds. 

Sales commissions paid to broker-dealers in connection with the sale of shares of the Funds sold without a front-end sales load ("FESL"), which include B and C shares, are capitalized and amortized on a straight-line basis over a period not exceeding eight years.  CDSCs received by the Company are recorded as a reduction of unamortized deferred sales commissions.  In accordance with Statement of Position 98-5, the commissions paid for the sale of Integrity Fund of Funds, Inc.'s shares have been expensed as incurred.  The CDSCs received from early redemptions from Integrity Fund of Funds, Inc. have been recorded as revenue.  Sales commissions amortized can be expected to decrease if sales of shares of Funds sold without a FESL decrease. 

Depreciation and amortization 

Depreciation and amortization expense for the quarter ended March 31, 2008 was $28,695, a decrease of 73% from $106,657 for the quarter ended March 31, 2007.  The decrease was due to accelerated amortization of computer software costs during 2007. 

Interest and other income 

Interest and other income for the quarter ended March 31, 2008 was $204,371, an increase of 107% from $98,529 for the quarter ended March 31, 2007.  The increase was due primarily to an increase in marketing allowances received by CFS. 

Liquidity and capital resources 

Net cash provided by operating activities was $286,109 for the quarter ended March 31, 2008, as compared to net cash used by operating activities of $318,959 during the quarter ended March 31, 2007. 

Net cash used by investing activities was $29,793 for the quarter ended March 31, 2008, compared to net cash used by investing activities of $100,141 for the quarter ended March 31, 2007.  During the quarter ended March 31, 2007, the primary use of cash for investing activities was the purchase of additional computer equipment. 

Net cash used by financing activities was $75,730 for the quarter ended March 31, 2008, compared to net cash provided by financing activities of $153,889 for the quarter ended March 31, 2007.  During the quarter ended March 31, 2008, the Company paid out $22,875 in preferred stock dividends, made a $34,143 payment relating to the United Heritage acquisition (see Note 5 - Business Acquisitions), and repaid $20,885 of bank debt. 

At March 31, 2008, the Company held $3,323,836 in cash and cash equivalents, as compared to $3,143,250 at December 31, 2007.  The Company is required to maintain certain levels of cash and liquid securities in its broker-dealer subsidiaries to meet regulatory net capital requirements. 

In March of 2007, the Company borrowed $120,085 from First Western Bank & Trust.  The current balance of $95,085 carries an interest rate of 6.50% and matures on April 15, 2009. 

The Company has historically relied upon sales of its equity securities and debt instruments, as well as bank loans, for liquidity and growth. Management believes that the Company's existing liquid assets, along with cash flow from operations, will provide the Company with sufficient resources to meet its ordinary operating expenses during the next twelve months.  Significant unforeseen or extraordinary expenses may require the Company to seek alternative financing sources, including common or preferred share issuance or additional debt financing. 

In addition to the liabilities coming due in the next twelve months, management expects that the principal needs for cash may be to advance sales commissions on Funds subject to CDSCs, acquire additional investment management or financial services firms, acquire the management rights to additional outside mutual funds, repurchase shares of the Company's common stock, and service debt. 

Sales of Fund shares with FESLs provide current distribution revenue to the Company in the form of the Company's share of the FESLs, and distribution revenue, over time, in the form of 12b-1 payments.  Sales of Fund shares subject to CDSCs provide distribution revenue, over time, in the form of 12b-1 payments and, if shares are redeemed within five years, CDSCs.  However, the Company pays commissions on sales of Fund shares subject to CDSCs, reflects such commissions as deferred sales commissions on its balance sheet and amortizes such commissions over a period of up to eight years, thereby recognizing distribution expenses.  Therefore, to the extent that sales of Fund shares subject to CDSCs increases over time relative to sales of shares subject to FESLs, current distribution expenses may increase relative to current distribution revenues in certain periods, which would negatively impact the Company's cash flow in such periods.  In addition, the Company may need to find additional sources of funding if existing cash flow and debt facilities are insufficient to fund commissions payable to selling broker-dealers on shares subject to CDSCs if sales of Fund shares subject to CDSCs increase significantly. 

FORWARD-LOOKING STATEMENTS 

When used herein, in future filings by the Company with the Securities and Exchange Commission ("SEC"), in the Company's press releases, and in other Company-authorized written or oral statements, the words and phrases "can be," "expects," "anticipates," "may affect," "may depend," "believes," "estimate," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made.  Such statements are subject to certain risks and uncertainties, including those set forth in this "Forward-Looking Statements" section, which could cause actual results for future periods to differ materially from those presently anticipated or projected.  The Company does not undertake and specifically disclaims any obligation to update any forward-looking statement to reflect events or circumstances after the date of such statements. 

The Company derives substantially all of its revenues from two sources; commission revenue earned in connection with sales of shares of mutual funds, insurance products, and various other securities; and fees relating to the management of, and provision of services to, the Funds.  The fees earned by the Company are generally calculated as a percentage of assets under management.  If the Company's assets under management decline, or do not grow in accordance with the Company's plans, fee revenues and earnings would be materially adversely affected.  Assets under management may decline because redemptions of Fund shares exceed sales of Fund shares, or because of a decline in the market value of securities held by the Funds, or a combination of both. 

In seeking to sell Fund shares and market its other services, the Company operates in the highly competitive financial services industry.  The Company competes with over 8,700 open-end investment companies that offer shares to the investing public in the United States.  The Company also competes with the financial services and other investment alternatives offered by stock brokerage and investment banking firms, insurance companies, banks, savings and loan associations, and other financial institutions, as well as investment advisory firms.  Most of these competitors have substantially greater resources than the Company.  The Company sells Fund shares principally through third-party broker-dealers.  The Company competes for the services of such third-party broker-dealers with other sponsors of mutual funds who generally have substantially greater resources than the Company.  Banks in particular have increased, and continue to increase, their sponsorship of proprietary mutual funds distributed through third-party distributors.  Many broker-dealer firms also sponsor their own proprietary mutual funds, which may limit the Company's ability to secure the distribution services of such broker-dealer firms.  In seeking to sell Fund shares, the Company also competes with increasing numbers of mutual funds that sell their shares without the imposition of sales loads.  No-load mutual funds are attractive to investors because they do not have to pay sales charges on the purchase or redemption of such mutual fund shares.  This competition may place pressure on the Company to reduce the FESLs and CDSCs charged upon the sale or redemption of Fund shares.  However, reduced sales loads would make the sale of Fund shares less attractive to the broker-dealers upon whom the Company depends for the distribution of Fund shares.  In the alternative, the Company might itself be required to pay additional fees, expenses, commissions, or charges in connection with the distribution of Fund shares, which could have a material adverse effect on the Company's earnings. 

The fact that the investments of some Funds are geographically concentrated within a single state makes the market value of such investments particularly vulnerable to economic conditions within that state.  In addition, the states in which the investments of the Funds, as a group, are concentrated are themselves concentrated in certain regions of the United States.  The Company's fee revenues may, therefore, be adversely affected by economic conditions within such regions. 

The following factors, among others, could cause actual results to differ materially from forward-looking statements, and future results could differ materially from historical performance: 

·         General political and economic conditions which may be less favorable than expected;

·         The effect of changes in interest rates, inflation rates, the stock markets, or other financial markets;

·         Unfavorable legislative, regulatory, or judicial developments;

·         Incidence and severity of catastrophes, both natural and man-made;

·         Changes in accounting rules, policies, practices, and procedures which may adversely affect the business;

·         Terrorist activities or other hostilities that may adversely affect the general economy. 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

Not Applicable as a Smaller Reporting Company 

Item 4.

Controls and Procedures

 

The Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, pursuant to Rule 13a-15(b) of the Exchange Act.  Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective as of March 31, 2008, and that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed and summarized, and reported within the time periods specified by the SEC's rules and forms. 

There were no significant changes in the Company's internal controls over financial reporting during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. 

PART II - OTHER INFORMATION 

Item 1.

Legal Proceedings

 

None  

Item 1A.

Risk Factors

 

Not Applicable as a Smaller Reporting Company 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

The Company has issued the following securities in the past quarter without registering the securities under the Securities Act: 

None 

Small Business Issuer Repurchases of Equity Securities:

Period	Total Number of Shares Purchased	Average Price Per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs
January 2008	-	-	-	$597,754
February 2008	-	-	-	$597,754
March 2008	-	-	-	$597,754
Total	-	-	-	$597,754

 

Item 3.

Defaults Upon Senior Securities

 

None 

Item 4.

Submission of Matters to a Vote of Security Holders

 

None 

Item 5.

Other Information

 

None 

Item 6.

Exhibits

 

Exhibits 

31.1	CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act and Rules 13a-14(a) and 15d-14(a) of the Exchange Act
31.2	CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act and Rules 13a-14(a) and 15d-14(a) of the Exchange Act
32.1	CEO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act and 18 U.S.C. Section 1350
32.2	CFO Certification Pursuant to Section 906 of the Sarbanes-Oxley Act and 18 U.S.C. Section 1350

  

INTEGRITY MUTUAL FUNDS, INC.
SIGNATURES 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant ha duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  

		INTEGRITY MUTUAL FUNDS, INC.
Date:	May 13, 2008	By /s/ Bradley P. Wells
		Bradley P. Wells
		Interim Chief Executive Officer
		and President
		(Principal Executive Officer)
Date:	May 13, 2008	By /s/ Heather Ackerman
		Heather Ackerman
		Chief Financial Officer
		(Principal Financial Officer)